In 1912, President William Howard Taft signed into law the Lloyd -- La Follette Act which protected civil servants from “unwarranted or abusive removal” and gave employees the right to furnish information to members of Congress without interference. This in effect became the first law to protect whistleblowers in the United States. Since then, numerous laws have been established to protect whistleblowers in both the government and the privates sector in areas as diverse as environmental regulations to taxes.
IRS whistleblowers -- those that report underpayment of taxes to the IRS -- have a financial incentive to report what they know. The IRS pays them a portion of the taxes, interest and penalties collected if their information leads to collection of additional tax receipts. The idea behind this is simple: The IRS can’t be in all places at once and this is seen as a way to turn almost anyone into a whistleblower. In recent years, payments by the IRS to whistleblowers have been diminishing. In order to re-incentivize whistleblowers, the IRS has changed the regulations regarding what is covered and how it is paid.
How IRS whistleblower payouts work
Whistleblower claims filed after December 20, 2006 are governed by Internal Revenue Code 7623(b) which establishes specific amounts, terms and conditions. Awards, to use the IRS term for payments to whistleblowers, are paid to individuals who provide specific information regarding noncompliance. The IRS must use the information to collect taxes, interest and penalties. Both of these conditions (specificity and use) must be met.
If the case involves a total disputed amount in excess of $2 million, the whistleblower is entitled to between 15 percent and 30 percent of the amount collected. If the amount is less than $2 million, the award is up to the discretion of the IRS and will not exceed 15 percent of the amount collected. If the whistleblower is not satisfied with the award, they can appeal in Tax Court only in the former cases (in excess of $2 million), but not the latter.
New regulations expanded to refunds
Previously, whistleblowers only benefitted if the IRS collected money, but not if the IRS saved money. For example, if a company reported and paid a $3 million tax liability but a whistleblower reports that they should have paid $5 million, then the IRS is able to collect an additional $2 million and the whistleblower may qualify for a reward. But if the same company had filed a return that showed a $5 million refund was due and a whistleblower reports that they are only owed a $3 million refund, the IRS saves the same $2 million, but in this case the whistleblower would not be entitled to an award.
That has now changed, and reductions in refunds now qualify for awards.
What your company needs to do about this
Whistleblowers are rewarded based on IRS collections using their information, not based on the intent of the company that underpaid. Even if the underpayment of taxes was an honest mistake, whistleblowers can still benefit and therefore they have the incentive to report it to the IRS. Make sure that your company takes these steps to minimize the risk of being subject to whistleblower actions:
- Get it right the first time. If your company is using overly aggressive tax accounting policies or cutting corners on its income tax filings to save costs, it’s a good time to correct these mistakes. Remember that even if you are due a tax refund whistleblowers can still benefit if the IRS is able to reduce the amount of the refund.
- Establish a culture of trust at work. If employees find a problem -- whether it’s due to honest mistakes or to something more sinister -- they should feel comfortable going directly to you as the owner. This gives you the opportunity to correct any errors voluntarily and avoid the costs, risks and embarrassment of being subject to whistleblower actions.
- Establish an internal whistleblower program. Provide incentives to your employees to turn information over to you. Whistleblower programs work. Put them to work for you. This article I wrote on employee fraud includes some good tips for establishing an internal whistleblower program.
Mike Periu is the founder of EcoFin Media, LLC which develops financial training, financial education, entrepreneurship training and more to small business owners on television, radio, print and the internet. Over the past ten years he has started three companies and advised over 50 companies on financial strategies including fundraising. Post your questions in the comments of this article.